Exchange rates affect the prices and profits involved in international trade. Because trade is part of aggregate demand, exchange rate movements can influence economic activity at home.
A company involved in international trade may pay its production costs in one currency and receive sales revenue in another. When it converts that revenue, the exchange rate determines how much it receives in its own currency. A change in the exchange rate can therefore alter a firm's profits even if its costs and sales prices remain unchanged.
All flashcards
Net exports
The value of exports minus the value of imports, written as X−M; net exports are one component of aggregate demand.
Currency mismatch
Exposure created when an institution's assets or income are denominated in a different currency from its debts or expenses.
Foreign-currency borrowing by a domestic-currency lender
A depreciation of the domestic currency raises the domestic-currency cost of servicing the foreign debt.
Why imports are not automatically harmful
Imports can benefit consumers with lower prices, help firms through less expensive inputs, and lead to payments returning through purchases of domestic goods, services, or assets.
How banking distress can affect aggregate demand
Bank failures can disrupt payments and restrict credit, reducing spending by firms and households.
Quiz questions
How are net exports defined?Answer: The value of exports minus the value of imports.
A French exporter earns dollars but pays costs in euros. What happens to the euro value of its dollar revenue if the euro strengthens against the dollar?Answer: It falls because each dollar converts into fewer euros.
A Thai bank owes $1 million. If the exchange rate changes from 40 to 50 baht per dollar, how many baht are needed to repay the debt, ignoring interest?Answer: 50 million baht.
Why can widespread bank failures reduce aggregate demand?Answer: They can disrupt payments and restrict credit for households and businesses.
Why might policymakers favor a weaker exchange rate during a recession?Answer: It may support aggregate demand.
Based on Principles of Economics 3e by Steven A. Greenlaw, David Shapiro, Daniel MacDonald (OpenStax), licensed CC BY 4.0. Adapted into a summary, flashcards and quizzes.